Deep out of the Money

Deep out-of-the-money (Deep OTM) options have strike prices far from the current stock price with very low probability of expiring in-the-money. For calls, deep OTM means strikes significantly above the stock price. For puts, it means strikes significantly below the stock price. These options trade for pennies, have deltas near zero, and almost always expire worthless. While buyers see them as cheap lottery tickets hoping for massive moves, sellers view them as nearly free money with extremely high win rates. Understanding deep OTM dynamics reveals why they’re usually terrible for buyers but can be goldmines for patient premium collectors willing to accept small returns for high probability.

Defining Deep OTM

Deep OTM typically means at least 15-20% away from stock price:

Deep OTM Calls: Strike 20%+ above stock price

  • Stock at $100, strikes $120 and higher
  • Delta typically 0.01-0.10
  • Nearly all extrinsic value
  • Lottery ticket territory

Deep OTM Puts: Strike 20%+ below stock price

  • Stock at $100, strikes $80 and lower
  • Delta typically -0.01 to -0.10
  • Catastrophe insurance pricing
  • Black swan protection

The deeper OTM, the lower probability but higher potential percentage return.

Deep OTM Premium Reality

These options trade for pennies with good reason:

Example: Deep OTM Call

Stock at $100, $120 call (20% OTM) trading at $0.15:

  • Intrinsic Value: $0 (would lose $20 if exercised)
  • Extrinsic Value: $0.15 (100% time/volatility)
  • Delta: 0.05 (5% chance of profit)
  • Weekly decay: Likely 100%

To profit, needs 20% move PLUS premium coverage – extremely unlikely.

The Penny Problem

Deep OTM often trades at minimum increments:

  • Bid: $0.00 (no buyers)
  • Ask: $0.05 (minimum price)
  • Can’t sell once bought
  • 100% loss common

Why Buyers Love Deep OTM

The lottery ticket mentality:

Massive Leverage Example

$5,000 to invest, stock at $50:

  • Buy stock: 100 shares
  • Buy ATM calls: ~3 contracts
  • Buy deep OTM calls: 100+ contracts

If miracle 40% move happens:

  • Stock: $2,000 profit (40%)
  • ATM calls: ~$6,000 profit (120%)
  • Deep OTM: $15,000+ profit (300%+)

This potential blinds buyers to probability.

The Psychology

  • Small loss feels acceptable
  • Huge gain possibility exciting
  • Like buying lottery tickets
  • Hope overrides mathematics
  • “What if” thinking dominates

Why Sellers Target Deep OTM

The probability advantage:

Income Generation Example

Sell 20% OTM weekly puts on quality stock:

  • Premium: $0.10 per contract
  • Capital required: $8,000 (for $80 strike)
  • Return: 0.125% weekly
  • Annual if consistent: 6.5%
  • Win rate: ~95%+

Small returns but extremely high probability.

Portfolio Protection Sales

Selling deep OTM calls on holdings:

  • Extra income on positions
  • So far OTM assignment unlikely
  • Supplements dividends
  • Nearly free money
  • Psychological comfort maintained

Deep OTM Greeks

Extreme Greek characteristics:

Delta: Near zero

  • Barely moves with stock
  • Needs massive move to matter
  • Non-linear if approached

Gamma: Very low but lurking

  • Can explode if stock approaches
  • Usually stays dormant
  • Black swan risk exists

Theta: High percentage decay

  • May lose 20% daily
  • Entire premium at risk
  • Accelerates to expiration

Vega: Surprisingly significant

  • IV changes matter more
  • Volatility spike helps
  • Crash kills value

Trading Deep OTM Successfully

Different approaches for buyers vs sellers:

For Buyers (Usually Don’t)

If you must buy deep OTM:

  • Only with true risk capital
  • Expect 100% loss
  • Need specific catalyst
  • Buy more time
  • Spread across strikes
  • Keep position tiny

For Sellers (Income Strategy)

Systematic deep OTM selling:

  • Quality stocks only
  • Multiple positions
  • Small size each
  • Let expire worthless
  • Avoid earnings/events
  • Compound small gains

Real World Deep OTM Events

When deep OTM pays off spectacularly:

GameStop 2021 Example

GME at $20, $60 calls trading at $0.05:

  • Stock exploded to $400+
  • Calls worth $340+ at peak
  • 680,000% return possible
  • Once in a decade event
  • Survivorship bias extreme

Market Crash Protection

SPY at $400, $300 puts for $0.25:

  • COVID crash to $220
  • Puts worth $80+
  • 32,000% return
  • Portfolio insurance paid off
  • Rare but memorable

These stories fuel buying despite terrible odds.

Deep OTM Spread Strategies

Using deep OTM in combinations:

Iron Condor Wings

Sell ATM strangle, buy deep OTM protection:

  • Short $95/$105 strangle
  • Long $85/$115 wings
  • Wings cost pennies
  • Define maximum loss
  • Sleep better at night

Ratio Spreads

Sell multiple deep OTM to finance ATM:

  • Buy 1 ATM call
  • Sell 3 deep OTM calls
  • Net credit possible
  • Risk if huge move
  • Income with upside

Common Deep OTM Mistakes

Buyers: Thinking low price = good value Sellers: Ignoring black swan risk Both: Poor position sizing Weekly: Not enough time for moves Earnings: Buying before IV crush

Managing Deep OTM Positions

Minimal management needed:

For Long Positions

  • Set and forget
  • Expect total loss
  • Don’t average down
  • Take miracle profits
  • Learn the lesson

For Short Positions

  • Let expire worthless
  • Don’t buy back at $0.01
  • Save commissions
  • Roll if challenged (rare)
  • Keep position size small

Deep OTM Income System

Building consistent returns:

The 10-20 Rule

  • Sell 10-20% OTM puts
  • 0.05-0.10 delta range
  • Multiple underlyings
  • Weekly expiration
  • 0.10-0.25% returns
  • 95%+ win rate

Monthly Allocation

$100,000 account example:

  • 20 positions of $5,000 each
  • Target $20-50 per position weekly
  • $400-1,000 weekly income
  • $1,600-4,000 monthly
  • Compounds significantly

The Mathematics of Deep OTM

Why sellers have edge:

Expected Value

Selling $0.10 put with 95% win rate:

  • Win: +$10 (95% of time) = +$9.50
  • Loss: -$200 (5% of time) = -$10.00
  • Expected value: -$0.50

Seems negative but:

  • Losses rarely maximum
  • Can manage before expiration
  • Diversification helps
  • Actual results often positive

Key Takeaways

Deep Out of The Money:

  • Strikes far from current price
  • Very low probability of ITM
  • Trade for pennies
  • Near-zero delta
  • Lottery tickets for buyers
  • Income generators for sellers
  • High win rate, low returns

Deep OTM options represent the extremes of options trading – nearly impossible dreams for buyers and nearly certain income for sellers. While buying them is usually burning money, selling them systematically can generate consistent small returns. The key is respecting the black swan risk while harvesting the high probability income. Remember: deep OTM sellers eat like birds but poop like elephants – many small wins can be wiped out by one massive loss if not properly managed.